Is Lloyds Banking Group PLC’s Slump A Buying Opportunity?

Shares in Lloyds Banking Group (LSE: LLOY) have fallen by 9% so far in 2016 and are down by 25% from last summer’s high of 89p.

What’s gone wrong? It’s not immediately obvious.

Lloyds has delivered rising profits, promised a dividend payment from this year and is expected to exit public ownership in 2016.

Although earnings forecasts have fallen over the last few months, Lloyds’ share price has fallen much faster. This means that on paper at least, Lloyds shares have become steadily cheaper.

Are there looming risks that investors need to worry about, or is this simply a great buying opportunity?

Rising profits

Lloyds’ 2015 performance didn’t give any obvious cause for concern. During the first nine months of 2015, the bank’s underlying profit excluding TSB (which has now been sold) rose by 10.8% to £6,237m.

Net interest margin, a key measure of profit, increased from 2.35% in the middle of 2014 to 2.63% at the end of September 2015. This makes Lloyds one of the UK’s most profitable big banks.

The bank’s financial health appears to be good too. Lloyds’ Common Equity Tier 1 Ratio (CET1) of 13.7%, a key regulatory measure, is higher than all of the other big banks. Bad debt costs also fell dramatically last year, and were 64% lower for the first nine months of 2015 than during the same period of 2014.

The latest forecasts indicate that a post-tax profit of £5,508m is expected for 2015. That’s 270% more than in 2014 and puts Lloyds on a 2015 forecast P/E of 8.3. A forecast dividend payout of 2.33p gives a prospective yield of 3.5%.

Possible problems?

Lloyds stock does face some potential headwinds. One of these is that the government has been offloading its stake in the bank and pumped 9%, or 6.4bn shares, back into the market last year.

That sell-off has now been paused, as Lloyds’ share price has fallen below the government’s breakeven price of 73.6p. However, the government still owns 9% of Lloyds and is keen to complete its sell-off in 2016. This overhang of unsold shares may be depressing the market. A second concern is that Lloyds may be losing momentum. After impressive profit growth in 2015, earnings per share are expected to fall by around 7% to 7.5p per share in 2016. This still leaves the stock looking cheap, on a forecast P/E of 9, but isn’t encouraging.

The possibility that interest rates will rise and trigger a housing slowdown is also a risk to Lloyds, which is the UK’s largest mortgage lender.

A value buy?

The market may simply be waiting for evidence that Lloyds’ 2015 earnings will meet expectations and that the outlook for 2016 remains solid. The bank’s 2015 results are due in February and could lift sentiment towards the shares.

The truth is that we don’t know what will happen next year, or even next week. Lloyds does appear to be financially strong and cheap relative to its expected 2015 earnings. A forecast 2015 dividend yield of 3.5%, rising to 5.4% for 2016, is also a major attraction.

In my view a buy at under 70p is likely to deliver decent long-term gains, but there’s no certainty of this.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.